Money and Banking
Midterm Exam
Course Introduction
Money and Banking explores the fundamental role of money in the economy, focusing on how financial institutions and markets facilitate the flow of funds and influence macroeconomic activity. The course examines the structure and function of central banks, the process of money creation, and the tools of monetary policy. Students will also analyze the behavior of interest rates, the significance of financial instruments, and the regulatory environment governing banks and other financial intermediaries. Emphasis is placed on the impact of monetary policy decisions on inflation, employment, and economic growth, both domestically and globally.
Recommended Textbook
Financial Institutions Management 5th Canadian Edition by Anthony Saunders
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Deposit-taking institutions (DTIs) play an important role in the transmission of monetary policy from the Bank of Canada to the rest of the economy primarily because A)loans to corporations are part of the money supply.
B)bank loans are highly regulated.
C)savings institutions provide a large amount of credit to finance residential real estate.
D)DTI deposits are a major portion of the money supply.
E)Canadian DTIs compete with foreign financial institutions.
Answer: D
Q2) Verifying the minimum level of capital or equity that must be held to fund the operations of an FI is part of the goal of
A)investor protection regulation.
B)safety and soundness regulation.
C)entry regulation.
D)credit allocation regulation.
E)consumer protection regulation.
Answer: B
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3
Chapter 2: Deposit-Taking Institutions
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Sample Questions
Q1) The maturity structure of the assets of banks tends to be shorter than the maturity structure of liabilities.
A)True
B)False
Answer: False
Q2) Retail deposits comprise the largest portion of deposits for Canadian banks.
A)True
B)False Answer: True
Q3) Since 1990, commercial banks decreased the proportion of business loans and increased the proportion of mortgages in their portfolios.
A)True
B)False Answer: True
Q4) As with other DTIs, profits or return on assets (ROA) is the primary goal of credit union management.
A)True
B)False Answer: False
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Chapter 3: Finance Companies
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Sample Questions
Q1) Compared to banks, why do finance companies often have substantial industry and product expertise?
A)Because they have no bank-type regulators looking directly over their shoulders.
B)Because they are specialized in market research and analysis.
C)Because they are often subsidiaries of corporate-sector holding companies.
D)Because they are more often willing to accept risky customers.
E)All of these.
Answer: C
Q2) Business loans represent 60% of the loan portfolio of finance companies.
A)True
B)False
Answer: False
Q3) Sales finance institutions compete directly with deposit-taking institutions for consumer loans.
A)True
B)False
Answer: True
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Page 5
Chapter 4: Securities, Brokerage, and Investment Banking
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Sample Questions
Q1) The dominant form of institutional venture capital firms operate as A)Corporation.
B)Subsidiary of a financial company.
C)Bank holding company.
D)Limited partnership.
E)General partnership.
Q2) Because the business of funds management generates fees based on the size of the pool of assets managed, the flow of income is more volatile than either investment banking function or the trading function.
A)True
B)False
Q3) Which of the following is NOT considered a trading activity of securities firms?
A)Position trading.
B)Pure arbitrage.
C)Liquidity trading.
D)Risk arbitrage trading.
E)Program trading.
Q4) As of 2012, equity capital in the securities industry measured over 12 percent. A)True
B)False
Page 6
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Chapter 5: Mutual Funds, Hedge Funds, and Pension Funds
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Sample Questions
Q1) The net asset value of a mutual fund is determined four times each business day.
A)True
B)False
Q2) Equity mutual funds may contain common stock, but not preferred stock.
A)True
B)False
Q3) A change from bank deposits to money market mutual funds typically allows an investor to benefit from higher yields, but with the cost of losing deposit insurance coverage.
A)True
B)False
Q4) An investor purchases fund shares with a 3 percent front-end load and expects to hold the shares for 10 years. The annualized sales load incurred by the investor is _______ per year.
A)3 percent
B)30 percent
C)0.3 percent
D)1.3 percent
E)1 percent
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Chapter 6: Insurance Companies
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Sample Questions
Q1) Separate accounts business of a life insurance company represents
A)policies written that cover individuals as a group.
B)liabilities owed to other life insurance companies as a result of reinsurance.
C)the cumulative cash value paid to policyholders if the policies are terminated before maturity.
D)a fund established separately from the other funds of the insurance company and invested without regard to the usual diversification restrictions.
E)the cumulative price that the company may repurchase policies from existing customers.
Q2) Factors that affect the predictability of claims loss exposure include
A)unexpected increases in inflation.
B)the frequency and severity of loss.
C)the concept of long-tail risk.
D)property versus liability coverage.
E)All of these.
Q3) The largest property & casualty (P&C) insurance companies have become less influential over the past decade.
A)True
B)False
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Page 8
Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually. What is the bank's net interest income in dollars in year 3, if it refinances all of its liabilities at a rate of 8.0 percent?
A)-$20,000.
B)-$10,000.
C)-$15,000.
D)+$20,000.
E)+$10,000.
Q2) As commercial banks move from their traditional banking activities of deposit taking and lending and shift more of their activities to trading, they are more subject to A)credit risk.
B)market risk.
C)political risk.
D)sovereign risk.
E)liquidity risk.
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) An increase in interest rates
A)increases the market value of the FI's financial assets and liabilities.
B)decreases the market value of the FI's financial assets and liabilities.
C)decreases the book value of the FI's financial assets and liabilities.
D)increases the book value of the FI's financial assets and liabilities.
E)has no impact on the market value of the FI's financial assets and liabilities.
Q2) If interest rates decrease 50 basis points for an FI that has a gap of +$5 million, the expected change in net interest income is
A)+ $2,500.
B)+ $25,000.
C)+ $250,000.
D)- $250,000.
E)- $25,000.
Q3) Because of its complexity, small deposit-taking institutions rarely use the repricing, or funding gap, model.
A)True
B)False
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Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) When does "duration" become a less accurate predictor of expected change in security prices?
A)As interest rate shocks increase in size.
B)As interest rate shocks decrease in size.
C)When maturity distributions of an FI's assets and liabilities are considered.
D)As inflation decreases.
E)When the leverage adjustment is incorporated.
Q2) Matching the maturities of assets and liabilities is not a perfect method of immunizing the balance sheet because the timing of the cash flows is likely to differ between the assets and liabilities.
A)True
B)False
Q3) For a given maturity fixed-income asset, duration increases as the promised interest payment declines.
A)True
B)False
Q4) As interest rates rise, the duration of a consol bond decreases.
A)True
B)False
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Chapter 10: Credit Risk: Individual Loans
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Sample Questions
Q1) Commercial real estate mortgages have been the fastest growing component of real estate loans.
A)True
B)False
Q2) The amount of leverage of a borrower and the probability of default are positively related, but only after some minimum level of debt.
A)True
B)False
Q3) The duration of a soon to be approved loan of $10 million is four years. The 99<sup>th</sup> percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the estimated risk-adjusted return on capital (RAROC) of this loan.
A)6.36 percent.
B)7.00 percent.
C)7.13 percent.
D)10.55 percent.
E)25.45 percent.
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Page 12
Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Sample Questions
Q1) In applying the loan loss ratio models, the loss rate "b" for the whole loan portfolio is A)0.
B)0.5.
C)1.
D)2.
E)negative.
Q2) If a bank's concentration limit (as a percentage of capital) is 25.0 percent, and it does not permit a loss of any loan to impact more than 10 percent of its capital, what is the expected recovery on loans that are defaulted?
A)20 percent.
B)30 percent.
C)40 percent.
D)50 percent.
E)60 percent.
Q3) The expected return of a portfolio of loans is equal to the weighted average of the expected returns of the individual loans.
A)True
B)False
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) Banks with relatively high loan commitments face less liquidity risk exposure than banks with a low level of loan commitments.
A)True
B)False
Q2) The price at which an open-end investment fund stands ready to redeem existing shares is the
A)strike price.
B)face value.
C)book value.
D)net asset value.
E)net worth.
Q3) A disadvantage of using stored liquidity management to manage a FI's liquidity risk is
A)the resulting shrinkage of the FI's balance sheet.
B)the high cost of purchased liabilities.
C)the accessibility of international money markets.
D)tax considerations.
E)loss of flexibility as a result of dependence upon purchased liabilities.
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Deviations from the international currency parity relationships may occur because of A)free capital movements across national boundaries.
B)barriers to cross-border financial flows.
C)perfect rationality of market participants.
D)differences in each country's productive capacity.
E)Basel capital regulations.
Q2) The FI is acting as a hedger when it
A)buys or sells currency to balance the FI's net exposure.
B)takes a nonzero net position in a particular currency.
C)processes an exporter's transaction in a foreign currency.
D)makes a market in a currency.
E)advises customers on their international business.
Q3) Violation of the interest rate parity theorem would allow arbitrage profits.
A)True
B)False
Q4) As the Canadian dollar appreciates against the Japanese yen, Japanese goods sold in Canada become less expensive to the Canadian consumer.
A)True
B)False
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Chapter 14: Sovereign Risk
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Sample Questions
Q1) For any given country risk variable, the greater the size of the systematic risk relative to the unsystematic risk, the less important the variable is to the lender.
A)True
B)False
Q2) A possible reason for the high systematic risk of VAREX in LCDs and EMs is
A)the tendency of world commodity prices to reflect non-similar economic conditions.
B)the sensitivity of this ratio to rising nominal and real interest rates in the developed, or lending, countries.
C)the tendency of prices and world demands for commodities to reflect simultaneously economic conditions.
D)the discretionary nature of money supply growth for LDC governments.
E)different demands for imports, and wide differences in the scale of vital imports across LDCs.
Q3) A lending decision to a firm in a foreign country should involve both a credit risk analysis and a sovereign risk analysis.
A)True
B)False
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16
Chapter 15: Market Risk
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Sample Questions
Q1) Sumitomo Bank's risk manager has estimated that the VaRs of two of its major assets in its trading portfolio, foreign exchange and bonds, are -$150,000 and -$250,000, respectively. What is the 10-day VAR of Sumitomo's trading portfolio if the correlation among assets is assumed to be -1.0?
A)-$100,000.
B)-$316,228.
C)-$1,106,797.
D)-$1,204,161.
E)-$1,264,911.
Q2) The JPM Risk Metrics model is based on the assumption of a binomial distribution of asset returns.
A)True
B)False
Q3) In the early 2000s the market risk capital requirement uniformly was a large proportion of the total risk capital requirements for the largest international banks.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) Up-front fees on loan commitments are charged as a certain percentage of A)commitment size.
B)loan taken down.
C)utilized portion of commitment size.
D)unused portion of commitment size.
E)interest payable on the loan commitment.
Q2) Loan commitments are classified as
A)on-balance-sheet assets.
B)off-balance-sheet assets.
C)off-balance-sheet liabilities.
D)on-balance-sheet liabilities.
E)equity capital.
Q3) Funds transferred on CHIPS are settled immediately.
A)True
B)False
Q4) Off-balance-sheet activities generally have risk-reducing attributes, but seldom have risk-increasing attributes.
A)True
B)False
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Chapter 17: Technology and Other Operational Risks
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Q1) Spruce Bank is planning to automate some of its back office functions and reduce operating costs. The installation of new computers and software will require an initial investment of $1,000,000. The savings generated because of reduced personnel cost is $200,000 per year. The bank uses an 8 percent rate of discount to evaluate cost saving projects which are expected to last 10 years. On further analysis, it is estimated that the project has a finite life of 5 years, i.e. further investment will be required to generate the same savings. Should they undertake the project if they assume a five-year horizon for evaluating the project?
A)Yes, because the NPV of the project is $500,000.
B)Yes, because the NPV of the project is $342,016.
C)No, because the NPV of the project is -$500,000.
D)No, because the NPV of the project is -$201,458.
E)No, because the IRR of the project is greater than 15 percent.
Q2) Cash management services include the collection, disbursement, and transfer of funds.
A)True
B)False
Q3) Combining the e-mail capability of the internet and the interbank payment networks to assist in the presentation and collection of invoices.
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Page 19
Chapter 18: Liability and Liquidity Management
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Q1) Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.
A)True
B)False
Q2) Which of the following is considered to be the most liquid asset?
A)T-notes.
B)T-bills.
C)Cash.
D)T-bonds.
E)Wholesale GICs.
Q3) Deposits with low withdrawal risk typically are the lowest cost deposits for a DI.
A)True
B)False
Q4) One method of reducing the risk of a liquidity crisis for an FI to efficiently manage liquid asset positions.
A)True
B)False
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20
Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) Statistical credit scoring models have been suggested for use in measuring the risk of DIs for the purpose of assigning deposit insurance premiums.
A)True
B)False
Q2) The insured depositor transfer method of failure resolution
A)results in the closure of the failed bank.
B)results in the merger of the failed bank into a stronger entity.
C)keeps the failed bank operating for a short period of time.
D)minimizes the deposit insurers' out of pocket costs of resolving a failed DTI.
E)forces insured depositors to bear some losses.
Q3) The system of flat deposit insurance premiums:
A)enhances bank safety and soundness because it discourages bank risk taking.
B)reduces bank safety and soundness because it encourages bank risk taking.
C)has no impact on bank safety and soundness.
D)places banks that are considered "too big to fail" at a disadvantage.
E)provides unfair advantage to small banks.
Q4) The risk of moral hazard increases when capital levels are low.
A)True
B)False
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Chapter 20: Capital Adequacy
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Sample Questions
Q1) Because DTIs may have little incentive to make high risk commercial loans, one important aspect of intermediation may be somewhat curtailed.
Q2) The primary role of capital for an FI is to assure the highest possible return on equity for its shareholders.
A)True
B)False
Q3) Losses in asset values due to adverse changes in interest rates are borne initially by the
A)equity holders of an FI.
B)liability holders of an FI.
C)regulatory authorities.
D)taxpayers.
E)insured depositors.
Q4) The book value of bonds and loans reflects the market value of those assets when they were placed on the books of an FI.
A)True
B)False
Q5) The four (five) risk weight categories in Basel I (Basel II) may not reflect the true credit risk.
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Chapter 21: Product and Geographic Expansion
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Q1) The Glass-Steagall Act in the U.S. allowed commercial banks to underwrite new issues of Treasury securities.
A)True
B)False
Q2) Of the ten largest financial service firms in the world, none are headquartered in Canada.
A)True B)False
Q3) Which of the following was not an operating characteristic of foreign banks operating in the U.S. prior to the International Banking Act of 1978?
A)They had no access to the Federal Reserve's discount window.
B)They were not subject to the Federal Reserve's audits and exams.
C)They had special rates on FDIC deposit insurance.
D)They could not use the Fedwire or the fed funds market.
E)They were not subject to the Glass-Steagall Act.
Q4) The U.S. Financial Services Modernization Act repealed the Glass-Steagall barriers between commercial banking and investment banking.
A)True B)False
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Chapter 22: Futures and Forwards
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Q1) The hedge ratio measures the impact that tailing-the-hedge will have on the number of contracts necessary to hedge the cash position.
A)True
B)False
Q2) In a forward contract agreement, the quantity of product to be traded, the time of the actual trade and the price are determined at the time of the agreement.
A)True
B)False
Q3) When will the estimated hedge ratio be greater than one?
A)When spot rate changes are greater than futures rate changes.
B)When spot rate changes are less sensitive than futures price changes over time.
C)When spot rate changes are equally sensitive as futures price changes over time.
D)When basis risk is absent.
E)When the spot and future exchange rates are expected to move perfectly together.
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Chapter 23: Options, Caps, Floors, and Collars
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Q1) The gain to a buyer of bond call options is unlimited, even if interest rates decrease to zero.
A)True
B)False
Q2) Allright Insurance has total assets of $140 million consisting of $50 million in 2-year, 6 percent Treasury notes and $90 million in 10-year, 7.2 percent fixed-rate Baa bonds. These assets are funded by $100 million 5-year, 5 percent fixed rate GICs and equity. On the advice of its chief financial officer, Allright wants to hedge the balance sheet with T-bond option contracts. The underlying bonds currently have a duration of 8.82 years and a market value of $97,000 per $100,000 face value. Further, the delta of the options is 0.5. What type of contract, and how many contracts should Allright use to hedge this balance sheet?
A)puts; 447 contracts.
B)calls; 625 contracts.
C)puts; 625 contracts.
D)calls; 447 contracts. E)puts; 206 contracts.
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Page 25
Chapter 24: Swaps
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Q1) By 2008, the insurance company AIG had more than $440 billion in credit default swaps outstanding.
A)True
B)False
Q2) Which of the following is true of the "netting" process in the swap market?
A)It decreases or mitigates the credit risk on swaps.
B)Both parties make payments to each other as a consequence.
C)It implies that the default exposure of the in-the-money party is the total fixed or floating payment.
D)It does not happen across contracts.
E)Netting by novation increases the potential risk of loss.
Q3) The largest segment of the global swap market is the currency swap market.
A)True B)False
Q4) The secondary market for the trading of swaps is second in liquidity to the U.S. T-bill market.
A)True
B)False
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Chapter 25: Loan Sales
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Q1) Which of the following is NOT a factor that may tend to increase loan sales in the future?
A)There is an increased trend to apply credit ratings to loans offered for sale, increasing the attractiveness to secondary market purchasers.
B)The federal government takeover of Fannie Mae and Freddie Mac means that the loans held by these agencies can never be sold to other entities.
C)Because of their special credit monitoring skills, FIs have a comparative advantage in making loans to below-investment grade companies and then selling the loan.
D)The trend toward marked-to-market accounting for assets makes bank loans more like securities so they may be easier to sell.
E)The risk-based capital requirements of the Bank for International Settlements give banks a strong incentive to sell commercial loans to decrease their amount of risky assets.
Q2) When a portion of a loan is sold from a large bank to a small bank, it is often called a participation.
A)True
B)False
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Chapter 26: Securitization Index
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Q1) The following information is for a collateralized mortgage obligation (CMO). Tranche A has a face value of $110 million and pays 5 percent annually. Tranche B has a face value of $90 million and pays 7 percent annually.
If at the end of the first year, the CMO trustee receives total cash flows of $15 million, how are they distributed?
A) $7.5 million to Tranche A and $7.5 million to Tranche B.
B) $15 million to Tranche A and nothing to Tranche B.
C) $5.5 million to Tranche A and $9.5 million to Tranche B.
D) $8.7 million to Tranche A and $6.3 million to Tranche B.
E) $7.1 million to Tranche A and $7.9 million to Tranche B.
Q2) Which type of loans are securitized most often?
A)Residential mortgages.
B)Credit card loans.
C)Auto loans.
D)Student loans.
E)Business loans.
Q3) Mortgage-backed bonds are a form of on-balance-sheet securitization.
A)True
B)False
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Page 28